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Tuesday, March 27, 2012

21. Inflation

The Concise Guide To Economics

by Jim Cox

21. Inflation

Inflation results from an increase in the money supply. The traditional definition is "a rise in the general price level," but this is actually an effect, not the cause. Most economists have given up trying to explain the difference in common discussion, partly because most people see the world through "Keynesian-colored glasses." Keynesian theory says there can't be inflation caused by an increase in the money supply (or from any other cause other than supply shocks reducing total supply) at the same time that there is unemployment. Any increase in the money supply, they say, will not cause inflation--it will just put people to work, not cause prices to go up.

The theory of inflation as an increase in the money supply, causing prices to go up, is consistent with basic supply and demand analysis. When there is an increase in the supply of a good, the value of each unit has got to go down. It is consistent with the law of diminishing marginal utility. It is consistent with our history--inflation in the United States has occurred at the same time that the money supply has increased (likewise in other countries).

A point that has been grossly underemphasized in economic theory is that people steal through the money system, and inflation is a means of doing that--by creating more new money, the value of everyone's existing money is undermined to the benefit of those receiving the newly created money. These would be the Federal Reserve first, then the banks, the government when it borrows the money from them, and so on down the line to the point where the dollar is worth much less when it gets to the average citizen. Inflation, then, is a result of special interest influence.

Stealing through the money supply is done today through the esoteric Federal Reserve System's open market purchases and fractional reserve banking. (The third way of stealing through the money supply is appropriately illegal--counterfeiting--but is in principle no different.) Thus Keynes's famous quote of Lenin is entirely correct:

Lenin was certainly right. There is no subtler, nor surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

The Federal Reserve's modern method of stealing through the money system is the parallel to the less sophisticated older means. The two primary former means were coin clipping and debasement. Coin clipping was the practice of filing the outer edge off a gold or silver coin and passing it on as if it still contained its full face value weight while keeping the filings as an ill-gotten gain. Mill marks on coins (tread on the outer edge) were used as protection against such stealing. Debasement is passing on a coin with all of the same look of a full weight of precious metal but with a cheaper base metal in place of the valuable precious metal. As can readily be verified, current U.S. coinage (properly called "tokens" not coins) has been totally devalued--the silver in a pre-1965 quarter is worth more than 1/4 of a dollar, and the zinc and copper in a post-1964 quarter is worth less than 1/4 dollar. These "coins" are made of cheap metals such as zinc and copper and the mill marks are there only out of nostalgia or attempted deceit!

The effect of this increase in the money supply is an increase in prices in general, but this is not the most troublesome effect of inflation. More problematic is the effect on morality as people realize hard work and saving are self-defeating, and the generation of the boom-bust of the business cycle due to the distortion of relative prices.